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Near-Term Uncertainties to Weigh on These Energy Stocks

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While we cheer the U.S. bull market’s 8-year anniversary, oil prices have broken below $50 a barrel after the Energy Department's weekly inventory release showed record high supplies and persistent strength in production. What’s more, even natural gas briefly fell back under the key psychological level of $3 per million Btu (MMBtu) following a bout of unseasonably mild temperature.

Therefore, although the OPEC-induced rally has helped commodity prices recover somewhat since late-2016, they still remain significantly below 2014 levels.

In fact, as long as there is big oil and natural gas surplus, the arduous market environment will continue -- suggesting that the odds are firmly stacked against a sustained rally. With U.S. crude stockpiles soaring on the back of robust shale production and natural gas unable to overcome the weather hurdle, money managers do not rule out chances of more pain ahead for energy stocks.

As there are no guarantees that things will improve in the near-to-medium term, investors would be better off ignoring the following set of stocks.

Natural Gas Market Turns Ugly

Natural gas rebounded strongly after hitting 17-year lows of around $1.6 per million Btu (MMBtu) in the first quarter of 2016, rising a phenomenal 150% to a cent below $4 at the end of December. However, selling came back to the market since then. Year-to-date, natural gas has performed the worst among major commodities. It dived more than 35% through late February and while prices have rebounded somewhat in March, they are still unable to stay above $3 for a reasonable period of time.

With the winter heating season – which runs from Nov 1 to Mar 31 – coming to an end and the injection season set to start, fundamentals point to 'lower for longer' prices. Agreed, this year there is around 16% less natural gas in storage compared to the year-ago period, but worryingly, the current stock is 15% more than the five-year average for this time of the year. A warmer winter translated into weaker demand for the heating fuel and upended demand forecasts. And now, as March comes to a close, one would expect tepid demand for the commodity with spring-like weather expected over most parts of the nation in the upcoming weeks.

The bottom line is that there appears no reason to believe that the supply glut will subside anytime soon and natural gas will be out of the dumpster.

In addition to Zacks Rank #5 (Strong Sell) Ultra Petroleum Corp. UPLMQ, natural gas-weighted exploration and production companies like Bonanza Creek Energy Inc. (BCEI - Free Report) and Comstock Resources Inc. (CRK - Free Report) look to be in most trouble. Gas-focused partnerships like Williams Partners L.P. WPZ and ONEOK Partners L.P. OKS tend to suffer too, from falling sales for their natural gas liquids (NGL) processing. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Refiners: Challenging Investment Environment Persists

A year ago, U.S. downstream (refining and marketing) stocks were seen notching up healthy gains and earnings beats. As oil tumbled to lowest level in more than 12 years, margins swelled. This is because the downstream companies use oil as an input from which they derive refined petroleum products like gasoline, the prime transportation fuel in the U.S. Hence, lower the oil price, higher will be their profits.

However, this also led to overproduction and stock build-up that now threatens to bite the refiners. Refiners have been struggling of late with the existing stocks of refined product inventories – gasoline and distillate – remaining at higher-than-normal levels despite healthy demand. Consequently, margins have narrowed forcing some of the operators to announce production cuts, postpone capital spending and retrench employees.

As per industry data from British oil major BP plc (BP) , refining margin – the income from converting crude into gasoline and diesel – dropped progressively last year. From $13.8 per barrel in the second quarter of 2016, it was down to $11.6 in the Jul-Sep period and ended the year at an even lower $11.4 per barrel – a decline of 17% over three quarters.

Last but not the least, the U.S. refiners are feeling the pinch of higher Renewable Fuel Standard (‘RFS’) costs to comply with new cleaner gasoline production rules.

In particular, we suggest avoiding exposure to PBF Energy Inc. (PBF - Free Report) , World Fuel Services Corp. (INT - Free Report) and Murphy USA Inc. (MUSA - Free Report) .

Bleak Outlook for Oilfield Equipment Suppliers

Despite early signs of recovery in North America, the current oilfield environment remains one of the most difficult. With new competitors entering the market and drilling contractors too rattled to make new investment decisions, oilfield machineries and equipment suppliers have seen their pricing fall drastically.

While firms catering to North American land drillers have been the worst affected, lack of new deepwater drilling orders are starting to haunt the subsea part of the industry. This comes after commodity price rout has already made a number of deepwater drilling projects uneconomical.

As such, with several quarters of reduced activity and diminishing contract backlog, most of the players are facing continued pressure on revenues, earnings and cash flows. With no signs of immediate improvement in market sentiment, 2017 is likely to rank as the third consecutive year of declining oilfield services spending. Even if commodity prices improve, the structural oversupply and pricing pressure will weigh on the sector components’ operating margins.

Companies like Hornbeck Offshore Services Inc. (HOS - Free Report) , Dril-Quip Inc. (DRQ - Free Report) and Gulfmark Offshore Inc. GLF look to be in most trouble. Eating through backlogs without replacing them with new business, cash flow for these operators are likely to dry up further.

Check out our latest Oil & Gas Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy.

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